Groaning under an austerity program that has pushed its unemployment rate higher than the U.S. rate during the Great Depression, Spain announced that its economy shrank by 0.4 percent in the second quarter of 2012 and that it would remain in recession until 2013. The country’s borrowing costs soared to all-time euro-era highs as uncertainty about the finances of its banks and regional governments gripped investors.

The new bout of doubt about Europe’s financial stability sent investors fleeing to the safety of U.S. Treasurys and German government bonds, driving already low rates even lower. In Germany, the yield on two-year government bonds was slightly negative for the 12th consecutive day, meaning people were effectively paying the German government to keep their money safe for that period.

The ramifications of Spain’s financial woes are even broader than those linked to Greece. Greece’s economy is about the size of Maryland’s; Spain’s economy is the 12th-largest in the world, outstripping Australia, Mexico and South Korea.

Economists predicted that the European Central Bank would soon intervene again and that European leaders would be able to fend off pressures for now, but ultimately the fate of the euro zone is a political issue and not just a financial one.

“They have a lot of cards to play,” said Kenneth Rogoff, a Harvard University economics professor and former chief economist at the International Monetary Fund. “The arc of the crisis will continue to escalate, and responses will escalate.”

But, he added, “the only endgame is political union, and that’s not even in the conversation at the moment. And without a political union that establishes a strong central government, this thing is going to blow up.”

Spain was the biggest factor rattling confidence and markets Monday. Spanish borrowing costs soared for the third straight trading day as fears grew that the country’s teetering financial situation was too dire to be calmed by a limited bailout of its banking system.

Bailout concerns

European leaders working to stanch the economic crisis recently gave Spain a partial bailout targeting its banks and coupled it with additional European oversight. But the $120 billion bailout was smaller than Spain sought and came with the condition that the Spanish government accept full liability for the loan, thus effectively driving up the government’s ratio of debt to gross domestic product. Granting Spain’s full request would have exhausted the pan-European bailout funds. Investors responded Monday by trading 10-year Spanish bonds at 7.39 percent, up sharply from Friday and up 1.44 percentage points over the past three months.

Spanish media reports over the weekend said that six of Spain’s troubled regional governments were preparing to ask the national government for financial assistance. Should that happen, Spanish leaders would come under more pressure to ask for aid beyond the money that was earmarked for their banking system last month.

Meanwhile, an international team of Greece’s lenders planned to visit Athens starting Tuesday to talk with the new Greek government about its plans to meet the tough demands of its $158 billion bailout plan. Over the weekend, Germany adopted an increasingly pugilistic tone while drawing a line against any more aid for the troubled Mediterranean nation.

“Europeans have already tumbled down a very steep fiscal hill and seem to be trying to roll an immense boulder back up — only to watch it roll down again and repeat their futile labors over and over,” Ed Yardeni, president and chief investment strategist at Yardeni Research, said in a note to investors. “In Greek mythology, that was the unhappy fate of King Sisyphus, who had to do this forever. It’s starting to feel like forever in Europe.”

The new fears over Spain, the euro zone’s fourth-largest economy, sent the euro to its lowest levels in more than two years, at $1.21.

Spanish regulators imposed a ban on short sales on Spain’s stock indexes to try to keep markets from plunging further. The reaction suggests that the initial bank bailout may turn out to be insufficient before it has even formally gone into operation. That will take place this week.

The market concerns “reflect problems in Spain as well as the euro zone,” Fernando Restoy, deputy governor of the Spanish Central Bank, said in Madrid, Reuters reported.

The yields on 10-year Spanish bonds are well over the 6 percent figure that sent Ireland, Greece and Portugal heading toward bailouts, and investors fear that no matter what Spain does to get its economy back on track, it will be crippled by high interest rates. Spain’s borrowing needs are limited this year, however, and Spanish officials have said they do not intend to seek additional bailout help.

Greece and Germany

In a sign of the heightened concerns, Spanish Economy Minister Luis de Guindos is to head to Berlin on Tuesday for talks with German Finance Minister Wolfgang Schaeuble. But Germany is more focused on Greece than on Spain, with some German officials over the weekend saying they will not commit any more money to the struggling country.

“A Greek exit from the euro zone has long since lost its horror,” Philipp Roesler, German deputy chancellor, told ARD television Sunday.

Roesler, who leads the pro-business junior-coalition Free Democratic Party, has talked tougher on Greece than Chancellor Angela Merkel or members of the Christian Democratic Union, but his comments echoed those made privately in recent weeks by other top German officials. Schaeuble also said Monday that Greece needs to hold to its bailout commitments.

If Greece requests more time to fulfill the mandates of the bailout, Germany would probably have to ante up more money to sustain the country in the meantime. To lengthen Greece’s time frame by two years — which is what Greek officials have suggested — would cost between $12 billion and $61 billion.

The German news magazine Der Spiegel reported Monday that the IMF was also threatening to withhold new funding from Greece. The IMF said in a statement Monday that it was “supporting Greece in overcoming its economic difficulties,” without specifically addressing the Spiegel report. Last week, IMF officials called for the European Central Bank to intervene to reduce Spain’s and Italy’s borrowing costs.

For now, Greece’s future in the euro zone appears to be a matter for negotiation.

“There are still some options that could keep the IMF in, although there are significant risks that the plug could be pulled altogether, given the increased zero tolerance on slippage from North European countries,” Nomura analysts Dimitris Drakopoulos and Lefteris Farmakis said in a research note Monday.

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